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It's one of the biggest challenges for today's retirees: how to afford an extended stay in a nursing home or assisted-living facility. With the tab steadily rising, sometimes hitting six digits per year, the solution requires real creativity.

A long-term-care insurance policy might appear to be the answer for some. Such policies are designed to help cover the costs of institutional or at-home care once a policyholder becomes unable to perform certain daily activities, such as dressing or bathing, or needs close supervision because of a cognitive impairment, such as Alzheimer's.

But long-term-care insurance is often uneconomical -- for both insurers and consumers. A recent report from Moody's Investors Service concludes that, despite the apparent need for this health-related, nonmedical coverage by an aging population, the future of the product is "uncertain" and the viability of the market itself is "now in question."

"The market is in flux, and we're finding out that there's no easy, clear-cut answer for anyone," says Carolyn McClanahan, founder of Life Planning Partners, a fee-only financial planning firm in Jacksonville, Fla.

Folks with less than $250,000 in savings aren't thought to be candidates for long-term-care insurance because they are the most likely to turn to Medicaid for such needs. Those with in-between levels of wealth -- up to $1 million or $2 million in assets, say -- arguably need long-term-care insurance the most but, as we will see, they are increasingly being priced out of the market for traditional long-term-care insurance policies.

Those most able to afford long-term-care insurance, people with more than $2 million in assets, are the least likely to need it,because they are in the best position to self-insure, or set aside money to cover potential long-term-care costs. Yet even they sometimes look to insurance to, for example, protect bequest amounts for heirs from an unexpectedly large cost for care.

"A lot of my clients can self-insure, but they choose to buy insurance to protect their legacy," says McClanahan. Increasingly, they, like many consumers, are exploring newer types of policies that combine life insurance or annuities with long-term-care insurance -- in effect, self-insuring part of the risk but covering themselves for a more catastrophic claim.

Between a third and a half of all 65-year-olds will use a nursing home at some point in their remaining lives, and 10% to 20% will stay for more than five years.
Yuri Arcurs/age fotostock

Even under the best of circumstances, long-term care is expensive. Nursing homes now cost around $80,000 a year on average (though they can top $100,000 a year in states like New York and New Jersey), and assisted-living facilities cost about half that much, according to a Genworth cost-of-care study. Between a third and a half of all 65-year-olds will use a nursing home at some point in their remaining lives, and of those who do, 10% to 20% will live there more than five years, according to economists Jeffrey Brown of the University of Illinois and Amy Finkelstein of MIT.

Half a million dollars in long-term-care expenditures is a big risk to bear -- exactly the sort of risk (large, uncertain) for which insurance seems ideally suited, the economists point out.

Yet, in the more than 30 years that long-term-care insurance has been in existence, the portion of elderly owning long-term-care policies has barely budged above 10%, leaving the vast majority of long-term-care expenditures uninsured and constituting "one of the largest uninsured financial risks facing the elderly in the United States," as Brown and Finkelstein put it.

Part, but not all, of the reason, they conclude, is the high cost of the policies.

JUST HOW COSTLY are long-term-care policies? To find out, Brown and Finkelstein compared the amount of money an insurance company will have to pay out on the average policy it sells, relative to the money it will collect in premiums. This is known as the policy "load."

For a typical long-term-care insurance policy purchased by a 65-year-old, the load was 32 cents on the dollar; that is, the insurance company will pay out only 68 cents in benefits for each dollar of premiums that it collects, on average, over the lifetime of the policy. This compares with loads on certain annuities of 15 to 25 cents, and to loads on group health policies of six to 10 cents.

When taking into account policyholders who let their policies lapse, the load is more like 50 cents. Unlike cash-value life-insurance policies, the typical long-term-care policy has no surrender value. If you cancel, you get no money back. And since premiums are "front-loaded" -- that is, designed to stay the same year after year even though benefits aren't typically paid until later years, if ever -- the cost of canceling a policy in the early years is particularly steep.

Brown and Finkelstein based their analysis on 2010 rates. Premiums have gotten only fatter, and benefits skimpier, since then.

The first long-term-care insurance policies were pretty bare bones, typically covering only nursing-home stays, and at a fixed dollar amount per day. In the late 1990s, the pendulum began to swing and a second generation of policies emerged offering much more generous benefits in a variety of settings, including nursing homes, assisted-living facilities, and the home. Often these policies featured lifetime benefits that increased with inflation, all for a seemingly low, level annual premium.

But higher-than-expected claims coupled with persistently and historically low interest rates, which lower investment earnings insurers rely on to help pay claims, led to huge premium increases. Insurers left themselves an out. Although they couldn't single out any one policyholder for a rate hike, they could raise rates on classes of policyholders -- all those in a certain age group, for instance. And that is exactly what they did. John Hancock, a unit of Manulife Financial, has pushed through average rate increases of 40% since 2010. In August, Genworth announced plans to raise rates on older policies by more than 50%, on average.

MANY INSURERS have substantially curtailed sales of new long-term-care policies or have stopped selling them altogether. Since 2010, at least five major players have pulled back from or exited the market, says Moody's, including John Hancock, once the No. 2 seller.

Those companies that remain -- Genworth is now the dominant player, with a more than 50% market share -- are scrambling to redesign their policies.

Among the new changes: longer deductibles, or the amount of time policyholders must receive care before benefits begin; shorter coverage lengths (policies offering lifetime benefits have virtually disappeared); smaller cost-of-living increases (or none at all) to the daily benefit amounts; tougher underwriting, including more blood work and cognitive testing.

And of course higher premiums across the board. In 2007, a healthy 55-year-old might have paid $1,500 a year for a policy paying benefits of up to $150 a day for three years. That same policy would cost more than $2,200 today, according to Moody's, which expects rates to continue to rise for the rest of this year and into 2013.

In addition, insurers are rolling out "hybrid," or "combination," policies in an attempt to limit their own risks as well as appeal to consumers concerned about rising premiums and the illiquidity of traditional long-term-care policies.

These are single-premium, cash-value life-insurance policies -- or annuities -- that provide payouts for long-term-care expenses, generally through a long-term-care insurance rider attached to the base policy. Long-term-care benefits, if triggered, come first from the base policy values and may continue, up to certain limits, after those values are depleted, depending on the contract's features, explains Carl Friedrich, a principal at Milliman, an actuarial consulting firm in Lake Forest, Ill.

Premiums can be steep, as much as $100,000 upfront for a 55-year-old for a policy that pays up to $100,000 a year in long-term-care benefits for a maximum of six years. However, if you cancel the policy you get back at least what you put into it, plus -- and this is a biggie -- the insurer can never come back to you demanding more money. There's even a small death benefit for your heirs, anywhere from around $200,000 to $300,000, depending on when you die. But if life insurance is what you're after, there are much cheaper ways to buy it. Nor is a combination policy likely to provide long-term-care benefits as generous as those on stand-alone long-term-care policies.

What this kind of policy can do is help leverage money you otherwise might have set aside to self-insure. If you die or require long-term care, you or your heirs could potentially receive benefits equaling two to six times your premium outlay.

Some consumers are starting to hedge their bets by buying both types of policies, but in smaller amounts. For example, a 55-year-old nonsmoker in average health who wants a $6,000 a month long-term-care benefit that compounds 5% annually and lasts six years might pay $5,400 a year for a stand-alone policy from Massachusetts Mutual, or $74,000 for a lump-sum-premium policy from Lincoln National with a similar benefit but no inflation adjustment, according to Peter Florek of MAGA, a long-term-care insurance agency in Riverwoods, Ill.

By splitting the difference and buying $3,000 a month of coverage from each company, he says, the premiums fall to $2,700 and $37,000, respectively. If the policyholder dies before age 72 without making a claim, the heirs would get a death benefit from the Lincoln National policy of at least $80,000, roughly equaling the sum of all the premiums paid to that point.

But even with a plan like this, Florek cautions, benefits may fall short of actual long-term care costs -- especially for those living in high-cost states. For now, anyway, insurance remains just a piece of the overall long-term-care funding puzzle -- and an expensive piece at that.